FHA mortgage insurance: What is it and how does it work?

When you buy a home with an FHA loan and don’t have at least 20 percent to put down, mortgage lenders require you to pay an FHA mortgage insurance premium (MIP), which protects them from loss if you can’t repay the loan.

FHA loans are attractive to some buyers because they come with lenient credit requirements, low closing costs and competitive interest rates. The added expense of FHA mortgage insurance, however, is a key drawback to this avenue of financing.

What is an FHA mortgage insurance premium (MIP)?

An FHA mortgage insurance premium (MIP) is an additional fee you pay to protect the lender’s financial interests in case you default on your FHA loan. FHA borrowers are required to pay two mortgage insurance premiums: one upfront at closing, and another annually for as long as you repay the loan, in most cases.

By comparison, conventional loans with less than 20 percent down come with private mortgage insurance (PMI), charged every year until you have at least 20 percent equity in your home. In this sense, PMI is different from FHA mortgage insurance, which doesn’t have the same equity cutoff.

How much does FHA mortgage insurance cost?

• FHA Upfront MIP: 1.75 percent of loan amount
• FHA Annual MIP: Varies based on the size, term and loan-to-value (LTV) ratio of the loan

MIP costs can vary depending on a few factors, including the term of your loan and the amount of money you put down. Shorter terms and larger down payments tend to result in lower MIP costs.

FHA loans with terms longer than 15 years

FHA loans with 15-year terms or shorter

FHA simple or streamline refinances

Upfront mortgage insurance premiums can be, and often are, financed into the loan amount, explains Peter Boomer, a mortgage executive with PNC Bank. Annual premiums are included in the borrower’s monthly mortgage payment.

If you borrow $100,000 and roll the cost of FHA upfront MIP into your loan, your loan amount will increase to $101,750 (an additional 1.75 percent of the loan amount). Naturally, that increases your monthly payment, as well. On a $101,750 30-year fixed-rate FHA loan at 4 percent, your monthly mortgage payment (excluding homeowners insurance and property taxes) would be $485, compared to $477 without financing the MIP.

Tack on the annual premiums, too, and your monthly payment will rise further, adding another $72 per month, bringing the total to $557. That’s assuming you make a minimum down payment of 3.5 percent, in which case you’ll be charged an annual MIP rate of 0.85 percent.

How long will you pay FHA MIP?

While the law has changed more than once on this issue, current guidance states that borrowers who put down less than 10 percent on an FHA loan must pay for FHA mortgage insurance until the entire loan term is over. If you put down at least 10 percent, however, you can have FHA MIP removed after 11 years of payments.

“The length of time that a borrower pays the monthly mortgage insurance premium varies depending upon the original loan terms,” Boomer says.

PMI on a conventional loan, on the other hand, can typically be canceled once a homeowner has built up 20 percent equity in their home.

Can you avoid FHA mortgage insurance?

Basically, no — if you’re using an FHA loan program. All FHA loans involve mortgage insurance, either for the life of the loan or for a set number of years.

You can avoid FHA mortgage insurance by:

• Using a different lending program – This could mean getting a conventional loan with a 20 percent down payment, but there are other options. One option is accepting an FHA loan and the MIP that it comes with, then refinancing into a non-FHA loan once you’ve built enough equity in your home.
• Obtaining a lender-paid mortgage insurance (LPMI) loan – LPMI can be an option if you’re not willing or able to make a 20 percent down payment. With this type of loan, the lender covers the PMI in exchange for a higher interest rate.
• Exploring a piggyback loan – With this type of loan, you make a 10 percent down payment, then get a second mortgage to add another 10 percent to your down payment. You wind up with a 20 percent down payment overall, avoiding PMI, but you’ll have to repay two loans.
• Looking into special programs – There are also some programs that allow borrowers to make a low down payment without PMI. These range from VA loans (for eligible members of the military) to programs directly from major banks and lenders. Many are geared to first-time homebuyers.

Cost of FHA MIP vs. PMI

The amount you pay for PMI can vary depending on your credit score, loan size and down payment amount, and, of course, your lender. Generally speaking, though, or borrowers with excellent or very good credit (FICO scores of 740 or higher), PMI payments can be lower than MIP payments. Larger mortgages tend carry higher premiums than smaller ones, as they involve more risk for the lender.

The average range for PMI premium rates is 0.58 percent to 1.86 percent of the original amount of your loan, according to the Urban Institute. While those figures look larger than MIP percentages, the fact that MIP payments must be made for at least 11 years or for the lifetime of the loan often makes them more expensive overall than PMI.

Bottom line on FHA mortgage insurance

It’s understandable to worry about the high costs of FHA mortgage insurance. The upfront premium is already a tough pill to swallow, and paying additional premiums for years or even decades can really eat into your budget.

MIP doesn’t have to be paid forever, however, depending on your down payment amount or if you refinance out of the loan in the future.

Plus, FHA loans have their advantages. “First-time homebuyers who find it difficult to save for a down payment with a high debt-to-income ratio, such as college graduates with student loan debt, would find an FHA loan helpful,” Acosta says.

In short, while it’s a drag, MIP shouldn’t be a deal-breaker if an FHA loan remains your best option for realizing your homeownership dream.

With additional reporting by Holly Johnson and TJ Porter